research summary

Founding Family Ownership and the Selection of Industry Specialist Auditors

Practical Implications:

This study uses different types of agency problems in family firms to explain their selection of industry specialists, therefore contributing to the literature by providing additional insight on corporate governance factors affecting firms’ auditor choice. The results provide policy-makers and practitioners with insight into differences in auditor selection criteria between family and non-family firms and how the differences in the severity of family firms’ agency problems affect their auditor choice.

Family firms have a distinctive ownership structure and different types of agency problems. Compared to non-family firms, family firms are subject to less severe agency problems between managers and investors, but more severe agency conflicts between family members and minority shareholders. As such, founding families are in an uncommon position to exert influence and control over their firms, potentially leading family firms to behave differently than non-family firms.

In addition, the U.S. General Accounting Office (GAO) issued a report (GAO 2003) identifying auditors’ industry expertise as a critical factor for firms’ auditor choice, and highlighting extreme levels of auditor concentration in some industries. Therefore, it is important to examine whether and how family firms’ unique ownership structure and agency problems affect their choice of industry-specialist auditors.

Design/Method/ Approach:

To empirically test the impact of family ownership on firms’ auditor choice, this study examines a sample of the S&P 1500 firms that have chosen Big N auditors during the period 2000–2008. Family firms are defined as those in which founders or their family members (by either blood or marriage) are key executives, directors, or blockholders, and the data are hand-collected from proxy statements and corporate history. The impact of family ownership on firms’ auditor choice is tested using a probit model. An audit firm is classified as an industry specialist if it maintains industry expertise at both national and city levels. In addition, the impact of different attributes of family firms on auditor choice is examined, including CEO type, the percentage of family holdings, and the use of control-enhancing mechanism (i.e. dual-class shares).

Findings:

The study finds that compared to non-family firms, family firms are more likely to hire industry-specialist auditors due to their strong incentives to signal the quality of financial reporting.

Due to the potential entrenchment problems, family firms with family member CEOs or with dual-class shares have even a higher tendency to hire industry-specialist auditors to signal their disclosure quality.